9/11: How the Global Economy Looked When The Planes Attacked
September 10, 2008
Economic activity had been slowing since mid-2000, not only in the United States but across a broad range of nations much as one observes some seven years after the attacks of September 11, 2001. A slowdown in U.S. GDP growth had exerted considerable drag on other industrial nations and most developing economies, weakening exports, investment spending, and share prices virtually everywhere.
The worlds’s second largest economy had misfired through the previous decade. Japanese GDP had expanded just 1.0% per annum, compared to 4.2% per annum in the ten years between 2Q81 and 2Q91. Prime Minister Koizumi was only six months into what would be 5-1/2 years in power, and he was preparing voters for another two years of difficulty. Many analysts, myself included, thought that such a forecast might prove too optimistic. Japan’s financial sector was still very unhealthy, and there was and still is too much over-regulation in that economy. Public debt was zooming and now is around 150% of GDP, but Japanese sovereign bond yields have stayed low to this day. Japan’s banking system is again sound, but vestiges of core deflation linger.
European governments in 2001 were focused on regional monetary and economic union, not their global responsibilities, and had overly emphasized the reduction of budget deficits, while paying too little attention to making labor markets mobile, fully utilized, and cost-competitive. Price stability then, like now, was treated as an end, rather than a means, as the ECB fought to establish anti-inflation credibility. The East Asian crisis of 1997-8 had left the region overly dependent on U.S. growth and unprepared to be a global locomotive as in the 1990 U.S. recession. Latin America and Canada were also very linked to the U.S. business cycle.
The U.S. had a critical mass of economic imbalances: a low savings rate, over-investment in high technology, a rising current account deficit, overvalued equity prices, excessive corporate and personal debt, and a drum-tight labor market. Oil prices had risen threefold from a monthly average low of $10.87 per barrel in December 1998 to 34.31 in November 2000, and the dollar’s 44% rise against the euro from that currency’s birth at end-1998 to the peak in October 2000 was another headache for the young European Central Bank, which raised its key rate by 90% from 2.5% to 4.75% and then dragged its feet on the ensuing monetary easing cycle as economic growth in Europe slowed. The Fed had been much more aggressive in stimulating the U.S. economy — cutting its rate by 275 basis points — but about a third of that support was neutralized by the appreciating dollar.
When the planes stuck, the U.S. slowdown had been limited mostly to the business sector. Personal consumption in 1H01 had expanded well over 2% saar, but overall GDP recorded annualized growth of -0.2% over the first three quarters of 2001. A 49% plunge of the Nasdaq in 2000 had not changed consumer attitudes because broader market gauges were resilient, and house prices were firm and poised for a boost from Fed easing. Right after the attacks, the Fed and most other central banks cut interest rates, acting in such complete unison for the first time since September 1985.
It was immediately thought after the 9/11 attacks that the global economy had been dealt a blow at a vulnerable moment and would do poorly in 4Q01 and not much better in 2002. The burden of of global growth seemed to rest ironically with the victim of the attacks, and hope rested on the lagged impact of Fed stimulus and substantial tax reductions that the Congress had passed. Some too drew from the example of the second world war and the prosperous 1960’s that war is good for growth.
The war on terrorism would be like not other war, with a difficult opponent to identify and unclear goals against which to measure progress. President Bush from the beginning warned that the war would not be completed quickly. The coming year of 2002, to again draw a parallel to the second world war, would be comparable to 1942, a period in which the allies suffered more setbacks than successes. And not since WW2 had America engaged in a major military operation leading to unqualified victory. The Korean War was a stalemate. Vietnam represented a political defeat that transformed into a military loss two years after U.S. troops pulled out. Although the Gulf War ended in overwhelming victory on the battlefield, the objectives had been defined narrowly, and broader political ramifications including the genesis of Islamic radicalism turned out very different from what was planned. “Uncertainty” was a constantly used word by economists in September 2001 but not overly so considering the circumstances. How would an already fragile U.S. and global economy overcome the drag on consumer confidence of fear that Bin Laden’s followers might strike again soon? An act bigger than the 9/11 attacks might prove catastrophic to the collective sense of psychological well-being. Would public malls, stadiums, modes of transportation, and theaters be safe? Without a trust to go to such places, consumer spending might dry up. While security may be priceless, it is not cost-free. A whole area of doing business was about to get expensive.
In retrospect, U.S. real GDP grew much better in 2002 than feared, proving that an old-fashioned Keynesian macroeconomic stimulus works in many circumstances. Real estate markets flourished, making consumers forget about the eventual hit that equities took. Other economies followed suit. Japan blossomed sooner than promised, and Europe experienced brisk growth with sharply falling unemployment after 2003. The long war has been just that. Seven years after Pearl Harbor (December 1948) came more than three years after WW2 had ended, and seven years after the Gulf of Tonkin Resolution (August 1971) was just 17 months from the end of U.S. involvement in the Vietnam War. The finish line to the war on terrorism is not in sight, and no longer boils down to capturing Bin Laden. U.S. growth over the whole time since 9/11 was clearly below a typical seven-year period, leading observers to wonder increasingly if the United States is headed for a decade-or-longer malaise like it went through in the 1930’s or that Japan experienced in the 1990’s.
Those who forget history are forced to relive it. I am struck by the similarity of economic conditions, policies, and expectations that prevail in September 2008 to those in September 2001. While worries about near-term economic conditions proved too pessimistic, with global growth truly sizzling along for several years, the productivity-led boom was not without its dark side. Many people did not see their standard of living rise in these seven years, and world growth was greased by a financial system that was far less understood and far more vulnerable than generally realized. Japan back-pedaled on reforms after Koizumi stepped down, and Europe and Canada are again demonstrating an inability to decouple from the U.S. business cycle. Some things do not change, but sometimes the biggest changes come from unexpected places. The main development of these seven years is one that was not discussed on September 12, 2001. I refer to the enormous real transfer of current and future resources to oil producers and Asian emerging nations led by China.
Can any of that be blamed on 9/11? President Calvin Coolidge famously said the business of America is business. The point of war is to preserve the freedoms and hopes that enable ordinary people to go about their business. In that broad sense, victory or defeat is not measured by what happens on the battlefield bu
t rather by what happens on the home field. If at the end of the day one’s foe in war is vanquished but the troops come home to an economy that is heavily indebted and struggling to compete in world markets, has victory been won?
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